The NYT’S Gretchen Morgenson has Eric Schneiderman & Beau Biden investigating the mortgage securitization practices of Bank of New York Mellon & Deutsche Bank. Shahien Nasiripour of Huffington Post also has Schneiderman looking at Bank of America. The key here is that New York and Delaware laws govern how securities must be formed and what paperwork has to be done on a specific timeline. What we have seen so far is that it appears to be widely the case that when mortgages were packaged together into securities, the originators failed to properly convey mortgage notes to the trusts as dictated by the Pooling and Servicing Agreements on the mortgage-back securities. If this was not properly, the net result is that instead of having mortgage backed securities, you have non-mortgage backed securities. The investors were sold something that they didn’t actually get and the ability for servicers to foreclose on securitized mortgages is dependent on them actually proving they the note and therefore having the right to foreclose.

David Dayen’s analysis is here:

This is an ENORMOUS deal. Schneiderman is looking at the failure to properly convey notes and mortgages to the securitization trusts, which court records clearly show was practically the industry standard during the housing bubble. Abigail Field’s work looking at just a handful of mortgages in one district court showed a perfect record of failure. These trusts were strictly time limited under New York law, and there’s no way for the banks to really make this right. By the way, the mortgages Field looked at had Countrywide as the originator. Countrywide is now part of Bank of America.

If this plays out as it could, Schneiderman could declare these securities invalid under New York trust law. There would be a lawsuit in response, of course, but the exposure of Bank of America for this claim is massive, potentially bigger than their capital reserves. Pretty much every investor in a BofA MBS would demand their money back on the faulty security. Not to mention the inability to foreclose on borrowers because of the lack of proof of ownership of the loan. We’re talking about trillions of dollars in losses on millions of loans with no true owner. It’s a nightmare scenario for the banks.

Obviously Schneiderman is just at the beginning of his probe. But at the least, this scrutiny of the loan documents shows that he’s completely not ready to join a 50-state settlement where he gives up his investigation in exchange for some nominal, piddling sum of money. That does not match his recent history and his ongoing investigations.

My big question will be at what point does the administration, Treasury, HUD, FTC, and the DoJ start leaning hard on Schneiderman, Biden, and the other state AGs who are conducting their own investigations into robosigning and foreclosure fraud (two things which come in large part due to the improper securitization Schneiderman and Biden are investigating) to stop them and get back on board with whatever Tom Miller negotiates. Schneiderman and Biden’s investigations have the potential to make a mockery out of any settlement – which will be coming without any meaningful investigation into the actual practices surrounding securitization, robosigning, foreclosure fraud or illegal servicer behavior.